Excessive Executive Compensation: When is Too Much, Too Much?

by Dr. Scott Brown

Excessive Executive Compensation: When is Too Much, Too Much?

by Dr. Scott Brown, Education Director, Investment U

Monday, June 8, 2009: Issue #1014

With every disclosure I receive on executive compensation coming out of failing and defunct firms it makes me sick - as an investor and citizen alike. And I'm not the only one...

Many Americans have been outraged as the CEOs and other executives responsible for the financial crisis have pocketed millions of dollars in bonuses and golden parachutes.

And rightfully so.

The recent bailouts of banks, automakers and insurance companies has brought excessive executive compensation into the public eye. And the numbers are staggering.

  • According to The Corporate Library, in 2008 the CEO of an S&P 500 company received an average compensation of $10.4 million. During that time the S&P 500 lost almost 40% of its value.

  • Yet despite these declines, CEO perks grew in 2008 to an average of $336,248 - a full nine times the median salary of a full-time worker. And that's just perks!

By monitoring executive compensation, you can be the first to know if the companies that you've invested your hard earned money in are legally stealing from you. Here's how you can tell how much "your" executives are being paid and whether it's in line or not.

Executive Compensation Rates: Directly Transfered From Poor to Rich

Even as CEOs walked away from the carnage they were morally responsible for - despite financial protection from congressionally issued "Stay Out Of Jail" passes - the economy tanked for working people as 1,200,000 rank-and-file workers lost their jobs in 2008 alone.

And where did the money come from to fund executive compensation packages driving even more cash to the top 1% of American wealth?

It was a direct transfer of $700 billion in taxpayer money from the poor to the rich!

  • These executives ran their corporations into the ground with mistakes that would have either fired a rank-and-file employee or rendered a lesser employee behind bars.

  • Instead of being punished, many of these executives are house hunting in over the top markets like Beverly Hills and the Hamptons.

  • Many of these executives offered excuses and clever lies for what they had done - dodging what they were responsible for.

Often just before they jumped ship - with loot in hand of course... Take this excuse for example:

  • "My compensation is never going to be an embarrassment to GE!" - Jeffrey Immelt, CEO of GE, February 2009 just before being grilled for insane compensation packages in some of the worst performing years of GE history.

The fact of the matter is that individuals with more responsibility who are producing more than typical value for their bosses and shareholders do deserve to make more money than the average worker.

But how much more?

Dr. Peter Drucker On The Executive Compensation Ratio

Well to answer the question about executive compensation ratios, I turned to a man whom many would argue to be the most cogent management professor of the last century: Dr. Peter Drucker.

  • He was one of the first to talk about responsibilities and accountability, not just of managers, but of employees as well.

  • Drucker's idea was that everyone is responsible in one way or another for the success of an enterprise. Everyone concerned has to be held accountable for their own actions; he used executive salaries as just one example.

  • Peter said executive salaries were clearly out of line with the responsibilities of those holding to positions.

  • Ratios of the compensation of American top managers to rank-and-file workers are the highest in the world - too high by his standards.

Drucker recommended that the ratio needs to be less than 20-to-1. So how do executive salaries stack up? Take a look.

The Whack-Onomics Of Executive Compensation Rates

In 2007 rank-and-file pay averaged $37,360.89. And based on his 20-1 ratio, Drucker showed that CEOs shouldn't be earning more than $747,217.78 on average in annual compensation.

Unfortunately, at 344 times typical salaries, executives are hosing America for $12,852,145 a year on average. Even more disturbing, half of all executive pirates make more than that... some much more.

The money to pay these ruffians comes from the bottom-line of stocks you own.

Is there a way to get back? Yes, Warren Buffett doesn't allow the heads of companies to get away with this when he sits on the board. He talks quietly and carries a big stick.

If he sells out the company stock tanks. And, even though most CEOs shiver at the thought of "Buffett on the board," shareholders bid the stock up in support of the "Oracle of Omaha." His careful stewardship of companies, and the discipline he requires of his investments make them better than most.

It also makes his stock, Berkshire Hathaway (NYSE: BRKB), a good addition to your portfolio.

How To Track The Executive Compensation Of Your Stocks

But we all can't wield the power of a multi-billionaire. So here's what I recommend. Track the amount of salaries of the top executives of the stocks you own. While many sites disclose this public information, the one I like is Reuters.

By going to their section on stocks - officers & directors, you can see how much each of the officers is making and how much of their compensation is done through salary, stock options or other compensation - perks like free rent, chauffeurs, or jets.

While pay can fluctuate between industries and companies, I suggest you compare your company to its direct competitors to see if their pay is out of line or within industry norms.

We also discuss how to find out whether the top employee is a good steward or a pirate at the helm in the Investment U course if you're looking to find out more.

It all starts with education,

Dr. Scott Brown

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